ICOs Explained

Initial Coin Offerings (ICOs) – Decentralizing Capital Markets

It is hard to do anything nowadays without having some heavy-accented guy pop up on your screen advertising for some ‘ICO’ based out of Switzerland, claiming the next ‘best thing since Bitcoin’. Perhaps more alarming than the methods these guys implement to market their campaigns are the ease they are able to do it – sans regulation. The traditional stock market IPO would never resort to Youtube and Facebook Ads to find investors to buy into their IPOs, nor would they gain much attention even if they did.

This isn’t necessarily a bad thing, as the concept of blockchains at it’s core is about removing the intermediary and creating genuine, transparent democracy – governed by the people. In a sense, with ICOs, they have achieved this.

What is an ICO?

An ICO, or Initial Coin Offering, is essentially a way for a company to raise funds, comparable to a stock market IPO, with one major difference. In an IPO, a company would raise funds by selling shares of their companies to potential investors, and generally hire an investment bank to underwrite the deal. Investors would buy their stock, or ownership in the company, and be able to sell or buy more at any time they desired, since the stock would trade on a public stock market.

Unlike buying a stock, investors are not actually buying a piece of the company in an ICO. Rather, they buy into the tokens, aka the currency in circulation in that ‘economy’. In other words, they are betting that the ‘economy’ they are investing in will someday be of value, and people will want to own the currency to participate in it. Understanding that, traditional metrics of due diligence cannot be applied to a crypto-based company the same way it would in investing in company stock. Owning stock, one buys ownership of a company. Buying a crypto token, one buys into the underlying ecosystem. Similar goals, but not the same.

To participate, an investor would invest using cryptocurrency – the cryptocurrency of whatever blockchain the ICO was conducted on. For the sake of simplicity, the most popular blockchain for ICOs is Ethereum, so to invest in an ICO, one could do so using Ether.

The Paradigm Shift Into ICO Markets

If you look at the ICO market, there are an abundance of interesting ventures, teeming with potential. In a way this is interesting to investors, seeing that the IPO market has been long ago cornered by greedy venture capitalists, fixing to make a quick buck and move on, like a swarm of locusts. Intermediaries are incentivized to set the IPO price as high as possible, providing a good exit for early investors and high fees for investment bankers.

This all changes in an ICO market. The intermediaries – the investment bankers, disappear completely, allowing the company to approach investors directly and keep more of what they raise. Furthermore, they have nothing to benefit by raising the price of their cryptocurrency, like a banker would for a stock price in an IPO. Insiders are not trying to exit, nor are intermediaries taking fees. With an IPO, company stock is offered to the public for purchase. In an ICO, a new ecosystem is attempting to be created.

Challenges with the system

The biggest concern with the ICO markets are that they are not regulated. Anyone with an idea can raise funds via an ICO, conducted completely in an online environment, without ever going through the vigorous due diligence process inherent with stock market IPOs. Technically speaking, people could whip together a fabricated but compelling story and be able to raise funds should they be able to garner a large enough following of believers. Granted, that is easier said than done, but possible nevertheless.

Another concern, and perhaps less of a concern at this point in time, is that ICOs are subject to price fluctuations in the cryptocurrency on which it is built on. As many may have noticed, we are living in volatile times in the cryptocurrency industry and drastic, unpredictable changes in cryptocurrency prices can be produced in a few short hours.

Monetary Policy In Cryptocurrencies

The fundamental argument for blockchains is essentially to decentralize everything, meaning there are no owners or governing bodies, invalidating the need for shareholders. Blockchain ecosystems are regulated by the people, for the people, so in a sense by owning the cryptocurrency of a blockchain, you are actually a shareholder – although not really.

An important factor to consider in buying into an ICO, a factor nonexistent in stocks, is the form of monetary policy implemented with regards to the cryptocurrency. Since one would be buying a ‘currency’, and not a share in a company, it is important to know how that currency will be managed. In the case of fiat currency, a central bank exists to control the monetary supply, intervening as they see fit based on market conditions. With cryptocurrencies, all of that is determined via code.

Critics of this system would immediately argue that functional human intervention is required to make decisions on monetary policy. It is too risky to leave it all to code. That is true, and there have been cases in the past of loopholes in code being exploited to issue more cryptocurrency. All of that can be fixed, however, and have been fixed, by majority consensus. Humans can intervene by majority consensus if the issue poses a threat to the entire ecosystem – a topic of discussion for another time. Other than that, the code, that was checked and revised by thousands of individual parties prior to launch, should be left to function as it should.

Different cryptocurrencies are built by different organizations, and thus all implement different approaches with regards to monetary policy. WAVES for instance, has a fixed circulation of currency – set at 100,000,000 waves. No new Waves will ever be issued, and the ecosystem is intended to function with the Waves in circulation. Ethereum, on the other hand, exists in a inflationary environment, as more Ether is constantly being issued into circulation – a different system of governance altogether.